How to Consolidate Your Debts Wisely
By Steve Gillman
Before you ask how to consolidate your debts, you might want
to take a good hard look at whether it's really a good idea or
not. That's what we'll do below, and then I'll have some tips
for debt consolidation, in case you still think it's necessary.
If you buy a television for $1,000 it costs you how much?
$1,000 (plus tax) if you pay cash. But if you use a credit card
that charges 13% interest and pay the minimum payments of 2%
per month, you'll end up paying $1,450 over the six years it
will take to pay it off. But that's not the worst of it yet.
Suppose you roll that credit card debt into a home mortgage
in order to "consolidate your debts" at a lower interest
rate. If you are paying 6% on a 30-year loan, you will then pay
a total of $2,160 for that $1,000 television. The interest alone
($1,160) is more than the TV cost.
This is a good example of why rolling debts into a consolidation
loan doesn't always make sense - even when the interest rate
is lower. Notice that the interest rate in this example is half
of the credit card rate, and yet you would still pay more than
twice as much in interest ($1,160 versus $450), because you are
paying for so much longer.
Usually it is best to just focus your efforts on the highest-interest-rate
debt you have and get that paid off as quickly as you can. Then
move on to the next highest-interest-rate debt, and so on. For
a more complete description of how to do this, see the page,
Fastest Way To Pay Off Credit
Card Debt. You also can sometimes get the balances reduced,
as explained on the page, Excessive
Credit Card Debt.
One last thought about using debt to buy consumer items. It
certainly can seem that you get to have more good stuff, but
that is only true if you look at it from the shortest time-frame.
Yes, this year you can buy more if you use credit. But if in
the end you pay twice as much for everything as a result, that
has to mean you only get to buy half as much in life. That's
half as many clothes, half as many vacations, and so on. It's
something to think about.
If you do consolidate your debts, make sure you pay off the
consolidation loan quickly or you may just end up paying even
more, as explained above. This suggests that if you roll the
debts into a home mortgage loan you should pay extra on it to
at least pay the consumer debt portion early. If you aren't sure
that you have the self discipline for that you might be better
off getting a separate loan - even at a higher interest rate
- to pay it all off and then have one payment that is manageable.
There are companies that effectively consolidate your debts
for you. They may negotiate lower payments with some lenders,
and handle all the various payments. You just send them a single
payment each month. There is a charge for a service like this
of course, so there may be better ways.
You may be able to do your own consolidation if and debt reduction
if you have the discipline. As you work to pay down the debts,
you can also transfer them bit-by-bit to the lowest-interest-rate
credit card that you have. To do this, you might take advantage
of any free balance transfers they offer, but there are other
ways as well.
For example, just stop using your high interest cards, and
start paying them off as fast as possible. To speed the process
up you can initially pay only the minimum due on your low-interest-rate
card and in fact use that to pay for almost everything. This
will free up money to quickly pay down the other balances, effectively
transferring them from those cards to the better one. Then, when
you have only one or two lower-cost cards with balances, start
paying those off as quickly as you can.
If you have a car that you own free-and-clear you can go to
a bank or credit union to get a loan using it as collateral,
then use that to pay off all other credit balances. As you can
see, the question of how to consolidate debts has more than one
answer. You can also see that just paying them off may be the
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